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written by | September 8, 2022

Sources of Business Finance: Classification of Sources of Funds

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To expand the business, companies constantly look for finance sources. The act of providing resources to support a programme, initiative, or necessity is referred to as funding, often known as financing. Financing can start for both short-term and long-term goals. 

Did you know?

The fiscal year 2020 had an all-time high capital collection through the public equities' instruments at 1,77,468 crore. 

What is Business Finance? 

Business finance is the money a company needs to launch and maintain its activities. A firm needs enough money to carry out its numerous tasks in order to operate. Any firm requires money to be able to manufacture goods or offer services. Longer-term expansion and growth objectives can only be met with the assistance of the necessary amount of funding. 

Business Finance Requirements

A business's financial requirements may be divided into two categories: 

Also read: Understand Unsecured Business Loans and Its Types, Advantages & Features

Fixed Capital Requirement: 

A company must invest capital in assets that are fixed in nature in order to launch a business. To buy fixed assets such as equipment, furniture, and fixtures, among other things, money is needed. The money put into fixed assets will stay there for a very long time. 

Working Capital Requirement: 

Working capital is the money necessary for daily operations. It is employed by the company to store current assets and settle current liabilities. 

Every firm has a different demand for fixed or working capital. While a company engaged in day-to-day trade will always be required to invest more in fixed capital and less into working capital, a company engaged in manufacturing will always be required to invest more in fixed capital. 

Sources of Funds 

Without funds, a company simply cannot operate, and the cash needed to keep a firm running is referred to as business finances. Funding is a constant requirement for businesses throughout their existence. Sources of funding are used for corporate operations. They are categorised according to their generation source, control and ownership as well as time period. 

Period Basis Sources 

The various funding sources may be divided into three categories based on the time frame. Those are: 

Long-term sources: 

Satisfy a company's financial needs for a period longer than five years. Other sources that are incorporated into it include long-term lines of credit, loans from financial firms, shares and debentures, among others. Such finance is typically necessary for the purchase of fixed assets like machinery, infrastructure, and other items. 

Medium-term sources: 

The areas where money is needed for a task that lasts more than a year although less than five years. The medium-term funding comes from commercial bank loans, government deposits, leasing finance, and mortgages from banking firms. 

Short-term sources:

Short-term sources are finances needed for a timeframe that is less than a year. Trade credit, bank loans, and deposit certificates are a few examples of sources that offer short-term funding. 

The financing of current assets, including inventory and receivable accounts, is frequently done via short-term borrowing. Seasonal enterprises sometimes focus on short-term finance for the interim phase across seasons since they must accumulate inventories in order to meet future sales objectives. Wholesalers and producers that have a large number of their resources in inventories and receivables also need a lot of money quickly. 

Also read: Comparing Business Loan Interest Rates - How to Identify and Apply for the Best Business Loan

Ownership Basis Sources 

The sources can be divided into Owner's funds or Borrowed funds according to ownership.  

Owner's funds are defined as funds obtained by a firm's owners, who might be sole proprietors, partners, or stockholders. This also includes earnings that are put back into the company. The owner's money stays invested in the company for a prolonged length of time and is not called for to be reimbursed throughout the company's lifetime. 

Owners' rights to managerial control inside the company are based on this funding. While some company owners may choose to retain full ownership of their company, others could favour risk sharing. 

The two main ways that owners might get money are through equity capital and retained profits. 

The term "borrowed funds" refers to money that has been raised through loans or other borrowings. For a major portion of the period, this form of funding source is employed since it is the most prevalent. Borrowing from banks and other financial institutions, mortgages from financial firms, the issuance of debentures, public deposits, and lines of credit are some of the ways to raise borrowed funds. 

These sources typically lend money under particular terms and circumstances for a set amount of time, and they must pay interest after that time has passed. The interest on these loans is paid by a borrower at a set rate. Oftentimes, it does place a significant strain on the company because interests must be paid even when revenues are small or a loss is incurred. These lenders don't take into account what a firm does after receiving a loan. Usually, the borrower's assets are used as security for the borrowed amounts. 

Generation Basis Sources 

It depends on the organisation whether the money comes from internal or external sources to categorise the sources of funding.  

Internal sources of funding 

Internal sources of funding come from within the company. For instance, a company can raise money itself by accelerating receivables recovery, getting rid of excess inventory, and growing its revenue. Only a small portion of the business's demands can be met by internal resources or funding. 

External sources of funding

On the other hand, external sources of funding are those that come from sources outside of an organisation, such contractors, lenders, and shareholders. When a significant sum of funds has to be generated, external sources are typically used. Comparing external funding to that obtained from internal sources, the former may be more expensive. 

When a firm needs money from outside sources, it may need to lease its assets as collateral. A few examples of typical external sources of funding utilised by corporate organisations include issuing debentures, lending from commercial financial institutions and banks and receiving public deposits.

Also read: All About E-commerce Business Loan In India - How To Apply, Step-By-Step Guide

Factors Affecting the Choice of the Source of Funds: 

Different sorts of enterprises have various financial requirements. As a result, businesses turn to a variety of funding sources. Companies choose to employ a variety of sources instead of depending on a single one since no source of funding is risk-free and without certain restrictions. We'll go over each one as it influences the decision to choose this combination: 

Cost: 

When choosing the type of finances that will be utilised by an organisation, both the cost of obtaining the funds and the cost of using them are taken into account. 

Financial Strength and Stability of Operations: 

The company's financial status and stability should be taken into consideration. A firm has to be financially secure since money must be returned to the source from which it was borrowed. Preference shares and debentures should not be purchased when the company's financial status is unstable. 

Form of Organisation and Legal Status: 

A business's legal structure either permits or forbids the use of various funding alternatives. For example, only a public corporation, not a partnership firm or even a private company, can offer equity stock to raise capital from the market. 

Purpose & Period: 

The choice is greatly influenced by the objectives and time. In contrast to long-term use of money, which has a variety of sources from which a corporation can pick, short-term use of finances also has a variety of sources. 

Risk Profile: 

Distinct types of financial sources have different risk factors linked with them. For instance, there is the least risk of stock since dividends are not required to be paid when there is no profit, and shareholding must only be reimbursed at the point of winding up, but with debentures, the interest payment conditions are the complete opposite. 

Control: 

A firm must give up some ownership and control to the investor in order to raise money by offering equity shares, but it need not do so when raising money by borrowing money or issuing debt securities like debentures. 

Also read: Grocery Store Business Loan - How To Apply, Features, Documents Required

Conclusion:  

Business finance is the money a company needs to launch and maintain its activities. Retained profits, loan financing, and equity financing make up the primary sources of finance. Retained earnings from company operations are used by companies to grow or pay dividends to their stockholders. Companies can raise money by either going public or taking out commercial bank loans. Companies receive equity investment from equity investors by swapping rights of ownership for funds. 

Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What is the importance of sources of funds?

Ans:

Despite many attempts, numerous start-up concepts never receive funding. Investors and lenders won't grant funds if a business plan is too risky or perhaps the loan application has a bad credit history. Without finance, those without access to personal funds are unable to start a firm.

Q: What are the main sources of funds for the project?

Ans:

Many different sources of funding may be used for operations. Equity, debt, and grants from the government are the key sources. The total cost, cash flow, final obligation, and entitlements to project earnings and assets are all significantly impacted by financing from these different sources.

Q: What is meant by sources of funds?

Ans:

Refers to where the specific funds or any other financial instruments that are the focus of the transactions between a mortgage lender and the consumer came from. Another way to define SOF is the source and mode of transfer of funds that are approved for the account.

Q: How can you classify sources of funds on the basis of ownership?

Ans:

The sources can be divided into "owner's funds" and "borrowed funds" according to ownership. Owner's funds are finances that are contributed by an enterprise's owners, who might be sole proprietors, business partners, or stockholders. In addition to money, it also comprises revenues put back into the company.

Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.